Asset backed securities

Asset-backed securities, called ABS, are bonds or notes backed by financial assets.

Typically these assets consist of receivables other than mortgage loans, such as credit card receivables, auto loans, manufactured-housing contracts and home-equity loans.

ABS differ from most other kinds of bonds in that their creditworthiness (which is at the triple-A level for more than 90% of outstanding issues) derives from sources other than the paying ability of the originator of the underlying assets.

Financial institutions that originate loans (including banks, credit card providers, auto finance companies and consumer finance companies) turn their loans into marketable securities through a process known as securitization.

The loan originators are commonly referred to as the issuers of ABS, but in fact they are the sponsors, not the direct issuers, of these securities.

These financial institutions sell pools of loans to a special-purpose vehicle (SPV), whose sole function is to buy such assets in order to securitize them.

The SPV, which is usually a corporation, then sells them to a trust. The trust repackages the loans as interest-bearing securities and actually issues them.

The “true sale” of the loans by the sponsor to the SPV provides “bankruptcy remoteness,” insulating the trust from the sponsor.

The securities, which are sold to investors by the investment banks that underwrite them, are “credit-enhanced” with one or more forms of extra protection — whether internal, external or both.

ABS constitute a relatively new but fast-growing segment of the debt market. The first ABS were issued in 1985; in that year, the market for publicly offered ABS issues was $1.2 billion. In 2003, issuance totaled a new record of $479.4 billion.

It is estimated that a total of over $2.6 trillion of ABS were issued from 1985 through 2003